Guide to leases for business owners: Avoiding legal traps created by COVID-19
By Scott McKenzie, Emma Milne and Andrew Henshaw, Velocity Legal
This is a challenging time.
Many business owners are in damage control, dealing with the loss of revenue, supply chain issues and employment issues – all in a rapidly evolving environment. For business owners that lease premises, the terms of their lease (and continuing to pay rent) is yet another headache.
In this environment, many businesses have closed, or are feeling extreme pressure. However, there are also businesses experiencing booms (e.g. supermarkets, medical practices, logistics and freight). While there is no one size fits all solutions for business owners, the article sets out some of the key leasing considerations that business owners should consider.
The Prime Minister recently implored landlords and tenants to negotiate variations to leases to address the challenges caused by COVID-19. The upshot is that tenants and landlords should enter into negotiations without delay.
Quoting the Prime Minister:
‘We need landlords and tenants to sit down and come up with arrangements that enable them to get through this crisis so on the other side, the landlord has a tenant, which is a business that can pay rent and the business is a business that can re-emerge on the other side of this and be able to go on and employ people on the other side of these arrangements… This is part of the hibernation approach where we want people bespoke, customised to their own circumstances to sit down and work these things out. There is no rulebook for this.’
We recommend obtaining advice regarding your leasing obligations prior to entering into negotiations. It is also important to approach these negotiations strategically and with a focus on potential ‘win-win’ outcomes.
Closing the business.
Most retail leases require a tenant to keep premises open for trade, and not to close its business. However, many business owners have voluntarily decided to temporarily close their businesses (e.g. retail), despite being legally permitted to trade. Voluntarily closure of a business (even for a short period of time) should be managed carefully from a legal perspective to avoid unexpected consequences.
Closure of the building or shopping centre.
It is uncommon for leases to provide financial protection (e.g. rent adjustments) in the event that the tenant cannot use the premises.
One of the challenges in the current situation is that leases commonly deal with the scenario where physical damage renders the premises unusable, but they very rarely contemplate forced closure due to government lockdowns.
Depending on the circumstances, the tenant might also be able to make a claim that the closure of the building or shopping centre is a ‘derogation from the grant of a lease’ or an ‘interference with quiet enjoyment’.
Where the premises is covered by state legislation governing retail leases, the relevant retail leases act may also help to provide the tenant with a degree of reprieve in the event of a complete closure.
Landlord restricting access.
If a landlord restricts the tenant’s access to the premises, a tenant could potentially claim that the landlord is in breach of the requirement to provide ‘quiet enjoyment’ by compelling the closure of the business.
Tenants seeking a rent abatement or rent reduction due to a voluntary closure, or even a forced closure due to government announcements, face a challenging situation from a legal perspective. There may be creative arguments which can be made under the specific terms of the relevant lease, or under the relevant state legislation. However, in the absence of a government announcement (as of Wednesday 26 March 2020), tenants may be left to commercial negotiations with their landlord.
The recovery of ‘outgoings’ (i.e. expenses incurred by the landlord on behalf of the tenant) is not uniform across all commercial leases. Nevertheless, consideration should be given to whether certain services included in outgoings (e.g. cleaning services) should be adjusted in light of the current situation.
For example, in the context of an office lease where all team members are working from home, it might be appropriate for the tenant to request a significant reduction in the frequency of cleaning. Naturally, this downwards adjustment to the frequency would likely lead to a decreased expense being incurred by the tenant.
Alternatively, if the premises lease related to a medical clinic, it might be appropriate for the tenant to request additional cleaning services from the landlord, and for the landlord to also take additional measures to mitigate health risks in common areas.
Both landlords and tenants should review their insurance policies to determine whether any financial relief might be available.
- the tenant may have business interruption cover which is designed to ensure that the tenant can continue to pay rent despite the interruption; and
- the landlord may have loss of rent cover which might protect the landlord’s income in the event of a forced closure.
Prevention of health risks.
The tenant is often required to actively prevent health risks. The precise wording of these obligations will naturally influence what the tenant is required to do to avoid breaching the terms of the lease.
Tenant’s reporting obligations.
Leases commonly require the tenant to report health risks to the landlord (e.g. infectious diseases). In some circumstances, tenants may even be required to liaise with government authorities and implement any suggested measures at the tenant’s cost.
In light of the gravity of the COVID-19 pandemic, we recommend that tenants closely observe their reporting obligations under the lease.
Force majeure clauses (i.e. clauses which deal with unforeseeable circumstances that prevent someone from fulfilling their obligations under a contract) are not commonly included in leases. If your lease does contain a force majeure clause, it should be carefully analysed to determine its impact.
Although it is unclear at this stage what support the government will provide to landlords and tenants, the parties to a lease may wish to proactively negotiate a pathway forward. Some common items for discussion include:
- the provision of a rent-free period, often in exchange for a higher rent when the business returns to normality; and
- changing the rent calculation mechanism under the lease for the period of disruption (e.g. pegging the rent payable during the period of disruption to the turnover of the business).
We have extensive experience advising on commercial leases. We provide tailored solutions to business owners who are seeking clear cut advice in this uncertain time.
This article is the opinion of the author and in no way constitutes legal advice.
Scott is as sharp as they come. He guides his clients with precision and has an unrivalled hunger to find practical solutions to complex legal issues. Scott has been recognised as a leading commercial lawyer in Australia, and prides himself on tenaciously protecting his clients. If you want clear advice and exceptional outcomes, Scott is your man.
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Emma is a gun at property law. She is relentless and meticulous in finding solutions for her clients. Whether developer, landlord, tenant or investor, she gets the job done. You’ll also be in good company if you’re a Melbourne Storm, Renegades or Pies fan.
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Andrew leads Velocity Legal’s Sydney practice.
If you are in a fight with the ATO or looking to restructure your business, you should have Andrew in your corner. Andrew is passionate about getting wins for his clients, solving difficult legal issues, and giving his clients clear and confident guidance. Andrew is a Chartered Tax Advisor, holds a Masters of Law from the University of Melbourne and is the author of ‘Life, Death and Taxes’. Andrew is also a passionate snowboarder and is always up for the next adventure in life.